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SNB to dominate FX price action as liquidity dries up

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Massive intervention from the Swiss National Bank (SNB) has become one of the main drivers of price action in the currency markets and is likely to become more dominant as the summer lull approaches.

That should put upward pressure on currencies such as CAD, SEK and GBP, as the SNB rebalances its reserves and sells the EUR it receives while attempting to rein in CHF strength. “We know the currencies they hold and the currencies they don’t, and those they do have generally been outperforming,” says Adam Cole, head of FX strategy at RBC Capital Markets. “Their flow is ongoing and the rebalancing as a result is ongoing. It is going to become more and more important as markets become thinner over the summer.” As UBS notes, CHF buying has become a standard feature of the currency markets as the crisis surrounding the eurozone has showed little sign of abating. The Swiss bank’s client flow data shows that EURCHF saw its 12th consecutive week of selling last week, with all four of its client groups – asset managers, hedge funds, private clients and corporates – liquidating positions for the third week in a row. If investors are consistent in their demand for CHF, then the SNB has been equally determined in maintaining the SFr1.20 floor in EURCHF that it put in place in September, after the currency pair plunged to a record low and threatened to derail the country’s export sector. Few believe that the SNB, which faces no constraint to the amount of CHF it can sell, will give up on its intervention campaign anytime soon. Indeed, the central bank has stepped up its programme in recent months as worries about the future of the euro project have intensified, with its FX reserves rising by $54 billion in May and $69 billion in June. Barclays believes that understates the real size of SNB intervention, given that EURUSD depreciated by 6.5% in May and that FX swaps, which the central bank entered into in August 2011, have been rolling off gradually.

SNB has agressively defended EURCHF floor

 Source: SNB, Bloomberg, Barclays 
That means diversification flows from the EUR that the SNB receives are likely to continue as it rebalances its reserves. Its current mandate requires it holds 50% of its reserves in EUR, 26% in USD, 8% in JPY, 9% in GBP, 4% in CAD and 3% in other currencies, which includes AUD, DKK, SEK and SGD. To find the currency most likely to be influenced by those flows, Chris Turner, head of FX strategy at ING Financial Markets, adjusts the currency weights in the SNB’s portfolio by their liquidity, using the results of the Bank of England’s 2011 FX volume survey.

SNB FX buying adjusted for liquidity

 Source: SNB, BoE, ING
That shows relatively illiquid currencies stand to benefit most from the SNB’s diversification activity, with CAD topping the list. Turner notes that while EURCAD has fallen a long way already, further losses cannot be ruled out as the trend extends into September. He has an initial target of C$1.20 for the cross. While the Bank of Canada will be relatively sanguine about a fall in EURCAD – the central bank would be more worried about USDCAD dropping sharply given that 75% of Canada’s trade is with the US – other central banks whose currency is appreciating thanks to the SNB’s diversification are less likely to be so calm. Sweden’s Riksbank, for example, which is trying to loosen monetary policy, is unlikely to welcome the effective tightening that results from a stronger SEK. Indeed, SEK, which is clearly being affected by the rebalancing flow, is relatively illiquid generally and particularly illiquid over the summer. In truth, there is relatively little the Riksbank can do against the flows coming its way from Switzerland, meaning that the record low in EURSEK around SKr8.0000 might come into view faster than many think. Raghav Subbarao, strategist at Barclays, who recommends holding short EURCAD and EURGBP positions to take advantage of the SNB’s actions, also believes there is value in being short NOKSEK. “While the two currencies are driven by common factors and act as high-beta versions of the EUR, the SNB has no holdings in NOK,” he says. “Consequently, diversification should support SEK and weigh on NOKSEK.” While the effects of the SNB’s reserve re-allocation might already have had an effect on the world’s FX markets, as the summer holiday period gets into full swing and other flows recede, the central bank could turn into FX’s 800-pound gorilla.